Trade surplus – But who cares?

Friday, August 30th, 2019

Australia is lucky that President Trump does not rule the world, for he would claim that our massive FY19 trade surplus would need to be curtailed.

The trade surplus is mainly generated with China through our massive commodity and energy export sector. As for the US trade position, we have slipped into a deficit as the US continues to protect parts of its agriculture sector.

As our first few charts and tables show, Australia’s trade surplus has ballooned and has now virtually taken our current account into surplus as well. It is an extraordinary turnaround that highlights the exceptional returns being generated on capital investments made by international companies in Australia over the last 20 years – mainly in iron ore and LNG production.

The above table shows the transition of the Australian economy and trade position. While it shows the benefits of significant resource-based investment and the massive growth of China, it hides an inherent vulnerability to a cyclical decline in bulk commodity export prices.

The recent numbers released by the Australian Bureau of Statistics for June are below. They show that on seasonally adjusted terms, the trade surplus reached a record $8 billion in June. That represents a near $15 billion monthly turnaround on our trade position in mid-2016, and the trade surplus increased by $1.86 billion in May alone.

The total trade surplus for FY19 (end June) was $49.9 billion, and this was a massive increase of $42.3 billion on the FY18 result. The larger surplus resulted from an annual $66.6 billion increase in exports, which dwarfed import growth of $24 billion.

Total Australian exports have now surged to over $450 billion per annum or about 23% of Australia’s GDP.

In summary, there have been two major drivers of the trade surplus:

Increased export volumes (mainly iron ore and LNG), combined with solid lifts in their international market prices; and

Sustained devaluation in the AUD, which has benefited reported export revenues (as contracts are mainly priced and settled in USD).

The capital investment required to meet the demand surge from the growing Chinese economy was undertaken from about 2006 through to 2016. This capital investment drew in massive imports of capital goods to construct extraction, processing and export facilities. These capital imports were a significant reason why the trade deficit blew out in 2006 to 2008 (iron ore developments) and 2012 to 2016 (LNG developments).

Once facilities were built and investments were completed, the importation of heavy capital equipment began declining. This decline helped stabilise the trade deficit before the surge into surplus as export volumes and prices flowed through.

To illustrate this, we draw upon the following table which tracks the LNG capacity build-out over the last 14 years. We can observe the surge in output that followed investment in each project in the prior 3 to 5 years. Thus, the surge in output of LNG from 2015, followed capital investment undertaken from 2010.

The trade account transition and benefits are clearer to determine than the capital account flows (which track income and interest movements). This is because the substantial investments in these LNG plants were predominantly foreign funded (by the likes of Total, Chevron, ExxonMobil, Shell, Tokyo Gas and Osaka Gas). The debt servicing and equity dividend flows from these massive projects will transition through various mechanisms and many will be designed to minimise profit recognition and tax for their largely foreign owners.

However, the Australian fiscal position (budget) will benefit from various payroll taxes and royalties. We will examinine this fiscal impact below.

The trade account is combined with the capital account to determine the current account (the balance of trade and income). As can be seen in the chart below, the surge in export revenue and the trade surplus is now driving the current account towards a surplus.

Another driver of capital account income is our burgeoning growth in superannuation assets, and where more investment capital is being directed offshore as opportunities in Australia become harder to find. These investments result in higher offshore earnings (dividends and interest) that flow as a credit into the capital account.

Thus, it is quite possible that Australia will reach a current account surplus in the September quarter – and it would be the first surplus in over thirty years.

As noted above, it is trade with China that has substantially driven our surplus. The chart below shows the percentages of total Australian exports to and imports from China. China takes about 37% of our total exports, which is in excess of $150 billion per annum at current prices.

Australia’s trade account position with the US is largely the opposite – a growing deficit recorded over the last twenty years.

The significance of China’s export trade is shown in the next chart, which focuses upon Australia’s major commodity exports (including wool). Here we see that Chinese imports from Australia are about ten times the amount that the US imports from us, even though the US is a 30% bigger economy than China.

The above chart does not capture trade in services, particularly education and travel, where once again Australia enjoys burgeoning export growth with China, greatly exceeding that with the US.

The triangular relationship that has evolved between Australia with China (trade) and the US (defence) is challenged by the above trade observations. Further, given that US multinationals have minimised their tax obligations in Australia (and most other developed countries), the fiscal drain of trade and commerce with the US now threatens to challenge our established long term relationships. The US-China trade war, the unpredictability of President Trump, and emerging issues regarding Iran are putting this into focus, but with little Australian public debate.

Despite a near decade of poor trade outcomes (prior to FY16), Australia has maintained a relatively secure fiscal (public finance) position compared to most of our international peers. This will improve further if the surge in commodity export prices (mainly iron ore) secures the forecast of an underlying fiscal surplus for Australia in FY20.

It is expected that surging profits from iron ore and LNG exports will drive tax revenues higher in FY20 to support the Government’s forecast surplus. Indeed the current iron ore price of approximately US$85 is well above the budget estimate (US$70) and last year’s average price range of US$60 to US$70.

Some conclusions from our trade position

Whilst the trade account surplus may have peaked in the recent June quarter, we anticipate the current account to be maintained at a small deficit for the forseeable future. Indeed, the rapid decline in bond yields and therefore the reducing cost of servicing Australia’s foreign debt, suggests that Australia’s financial position is largely secure.

This leads us to conclude that the current level of the AUD is probably unsustainably low. The reason the AUD has weakened to such an extent is explained by the excessive use of monetary policy around the world. The collapsing of interest rates benefits highly indebted countries more than the fiscally prudent, and this phenomenon seems to have hit the AUD in a rather bizarre outcome.

Thus while we don’t see the AUD rapidly recovering, we do believe that the depreciation has been excessive, but welcome as a stimulant to the Australian economy. The weaker AUD supports trade in services and particularly supports inbound tourism and education.

Importantly, it is the weak AUD that leads us to conclude that a somewhat frail Australian economy is unlikely to drift into recession. Our international trading position is simply too strong.

AUD/USD over last 25 years

Source: Trading Economics

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